Mises Institute

Bank Charter Act 1844

The Bank Charter Act 1844 (or Peel's Act) was an Act of the Parliament of the United Kingdom, passed under the government of Sir Robert Peel. The Act restricted the note-issuing powers of British banks and gave exclusive note-issuing powers to the central Bank of England.[1]

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In 1844, Sir Robert Peel, a classical liberal who served as Prime Minister of Great Britain, put through a fundamental reform of the English banking system (followed the next year by imposing the same reform upon Scotland). Sir Robert Peel was profoundly influenced by the neo-Ricardian British economists known as the Currency School, who put forth a trenchant analysis of fractional reserve banking and central banking. The Currency School was the first group of economists to show how expansion of bank credit and bank notes generated inflations and business cycle booms, paving the way for the inevitable contraction and attendant collapse of business and banks. Furthermore, the Currency School showed clearly how the Central Bank, in Englandās case the Bank of England, had generated and perpetrated these inflations and contractions, and how it had borne the primary responsibility for unsound money and for booms and busts.

In an attempt to end fractional reserve banking and institute 100 percent money, the Peelites unfortunately decided to put absolute monetary power in the hands of the very central bank whose influence they had done so much to expose.

Specifically, Peelās Act of 1844 provided (a) that all further issues of bank notes by the Bank of England must be backed 100 percent by new acquisitions of gold or silver; (b) that no new bank of issue (issuing bank notes) could be established; (c) that the average note issue of each existing country bank could be no greater than the existing amount of issue; and (d) that banks would lose their note issue rights if they were merged into or bought by another bank, these rights being largely transferred to the Bank of England. Provisions (b), (c), and (d) effectively eliminated the country banks as issuers of bank notes, for they could not issue any more (even if backed by gold or silver) than had existed in 1844. Thereby the effective monopoly of bank note issue was placed into the not very clean hands of the Bank of England. The quasi-monopoly of note issue by the Bank had been transformed into a total legally enforceable monopoly. (In 1844, the Bank of England note circulation totaled Ā£21 million; total country bank note circulation was Ā£8.6 million, issued by 277 small country banks.)[1]

The Act regulated the operation of the then privately owned Bank of England until World War I. The Bank was divided into two separate departments, one for note issue and the other for deposit banking operations. Further increases in the note issue were limited to those issued against gold deposits. This provision, which prevented the further issue of fiduciary media in the form of banknotes, was suspended three times (1847, 1857 and 1866) before World War I (1914-1918). The gold requirements did not apply to the Banking Department which greatly expanded its deposits against bank loans and thus thwarted the efforts of the Currency School to prevent further credit expansion.[2]

By these provisions, the Peelites attempted to establish one bank in Englandāthe Bank of Englandāand then to keep it limited to essentially a 100 percent receiver of deposits. In that way, fractional reserve banking, inflationary booms, and the business cycle were supposed to be eliminated. Unfortunately, Peel and the Currency School overlooked two crucial points. First, they did not realize that a monopoly bank privileged by the State could not, in practice, be held to a restrictive 100 percent rule. Monopoly power, once created and sustained by the State, will be used and therefore abused. Second, the Peelites overlooked an important contribution to monetary theory by such American Currency
School economists as Daniel Raymond and William M. Gouge: that demand deposits are fully as much part of the money supply as bank notes. The British Currency School insisted
that demand deposits were purely nonmonetary credit, and therefore looked with complacency on its issue. Fractional reserve banking, according to these theorists, was only pernicious for bank notes; issue of demand deposits was not inflationary and was not part of the supply of money.

The result of this tragic error on bank deposits meant that fractional reserve banking did not end in England after 1844, but simply changed to focusing on demand deposits instead of notes. As a result, inflationary booms of bank credit continued immediately after 1844, leading to the final collapse of the Currency School. For as crises arose when domestic and foreign citizens called upon the banks for redemption of their notes, the Bank of England was able to get Parliament to āsuspendā Peelās Act, allowing the Bank to issue enough fractional reserve legal tender notes to get the entire banking system out of trouble. Peelās Act requiring 100 percent issue of new Bank of England notes was suspended periodically: in 1847, 1857, 1866, and finally, in 1914, when the old gold standard system went into the discard.[1]

Peelās Act to Regulate the Issue of Bank Notes was imposed on Scotland in July 1845. No new banks of issue were allowed in Scotland any longer; and the note issue of each existing bank could only increase if backed 100 percent by specie in the bankās vault. In effect, then, the Scottish banks were prevented from further note issue (though not absolutely so as in the case of England), and they, too, shifted to deposits and were brought under the Bank of Englandās note issue suzerainty.

One interesting point is the lack of any protests by the Scottish banks at this abrogation of their prerogatives. The reason is that Peelās 1845 Act suppressed all new entrants into Scottish note banking, thereby cartelizing the Scottish banking system, and winning the applause of the existing banks who would no longer have to battle new competitors for market shares.[1]